Today, I introduce a bill to strengthen the accountability and transparency of Australia’s executive remuneration framework and give shareholders more power over the pay of company directors and executives.

The bill implements the Gillard government’s response to the recommendations made by the Productivity Commission in its recent inquiry into Australia’s remuneration framework.

It is important that we have a system of remuneration that is not only internationally competitive, but that also appropriately rewards executives for their work and for the value that they bring to a company.

At the same time, directors should be accountable to shareholders for the level and composition of executive remuneration.

Shareholders are the owners of a company. They take on the risk of investing their capital and they share in a company’s profits and losses.

Shareholders, therefore, deserve more say over how the pay of company executives is set.

The government has sought to encourage shareholder engagement through the transparent disclosure of the details surrounding remuneration. This ensures that shareholders have the information they need to convey their views through the non-binding shareholder vote, and to hold directors accountable for their remuneration decisions.

While Australia’s remuneration framework is relatively strong, the global financial crisis highlighted a number of issues relating to remuneration structures.

In particular, it illustrated the dangers of remuneration structures that focus on short-term results, reward excessive risk-taking and promote corporate greed.

In March 2009, the government responded to these concerns by announcing reforms to curb excessive termination benefits or ‘golden handshake’ payments given to departing directors and executives. At the same time, the government also announced that it would ask the Productivity Commission to undertake a broader review of Australia’s remuneration framework.

The Productivity Commission undertook a thorough and comprehensive inquiry. Over the nine-month review process, the Productivity Commission received a total of 170 submissions and conducted a series of roundtables and public hearings.

Overall, the Productivity Commission found that Australia’s corporate governance and remuneration framework is highly ranked internationally.

However, it also recommended a range of reforms to further strengthen Australia’s remuneration framework.

The government, in its response to the inquiry, supported and further strengthened the majority of the recommendations. This bill implements many of these recommendations, and will put in place measures that will empower shareholders to influence the remuneration decisions of their company.

The ‘two-strikes’ test

A key measure in the bill is the ‘two-strikes’ test. This measure will subject the board of a company to greater accountability through the re-election process if it has not adequately responded to shareholder concerns on remuneration issues over two consecutive years.

The Corporations Act currently requires listed companies to put their remuneration report to a non-binding shareholder vote at the annual general meeting. While the introduction of the non-binding vote has seen a change in the way companies approach the compilation of their remuneration reports, shareholders currently have little recourse if boards choose to ignore strong ‘no’ votes.

The ‘two-strikes’ test gives shareholders more power to have their say.

Under this measure, the first strike is triggered where a company’s remuneration report receives a ‘no’ vote of 25 per cent or more. If this occurs, the company is required to explain in its subsequent remuneration report the action it has taken to address shareholders’ concerns. Alternatively, if those concerns have not been addressed, the company must outline the reasons why.

Some boards have already put in place processes to provide explanations of the issues surrounding remuneration to their shareholders, but it is not mandatory for them to do so. Formalising this practice for all listed companies will promote improved communication and engagement with shareholders.

If shareholders are still dissatisfied and the company receives another ‘no’ vote of 25 per cent or more at the following year’s annual general meeting, the second strike is triggered.

Once the second strike is triggered, shareholders are then given the opportunity to vote on a resolution to spill the board and subject the directors to re-election. If this spill resolution is passed by more than 50 per cent of eligible votes cast, then a spill meeting is to be held within 90 days, at which shareholders will be given the opportunity to vote on the re-election of the directors, one by one.

The Productivity Commission consulted extensively on this measure, particularly on the threshold level of a 25 per cent ‘no’ vote. The Productivity Commission concluded that a threshold of 25 per cent for each of the strikes was appropriate and is in line with the 75 per cent majority required for the passage of special resolutions.

A threshold of 25 per cent would better align with levels commonly accepted as demonstrating serious shareholder concern about remuneration, particularly in light of current voting patterns.

Whilst the threshold for each of the strikes will be set at 25 per cent, it should be noted that the threshold for the spill resolution will be set at 50 per cent.

This proposal targets the small number of boards that have not adequately addressed shareholder concerns over two consecutive years. The government believes that it is appropriate that these boards be subject to this additional scrutiny and accountability.

This measure sends a clear signal that unresponsive directors will be held accountable for their decisions on executive remuneration.

Remuneration consultants

The bill also contains measures to facilitate the independence of remuneration consultants.

The Productivity Commission inquiry concluded that the potential for conflicts of interest can arise where remuneration consultants report directly to the company executives and where they provide other services to the same company. Improved disclosure will help shareholders assess the independence of the advice that remuneration consultants provide to boards and their remuneration committees.

While the advice of remuneration consultants may be influential in determining a company’s remuneration decisions, it is important to recognise that the primary responsibility for remuneration arrangements rests with company directors.

The bill contains measures to require boards or remuneration committees to approve the engagement of a remuneration consultant. The remuneration consultant will be required to declare that their recommendations are free from undue influence and must provide their advice to non-executive directors or the remuneration committee, rather than directly to company executives.

In addition, boards will be required to provide an independence declaration, stating whether, in their view, the remuneration consultant’s recommendations are free from undue influence, and the board’s reasons for reaching this view.

The company will also need to disclose in its remuneration report key details regarding the consultant, such as the consultant used, the amount they were paid for providing remuneration recommendations as well as other services to the company.

These measures will deliver greater transparency for shareholders, as they will be in a better position to assess potential conflicts of interest associated with the use of remuneration consultants. By placing the onus on boards to demonstrate to shareholders the steps taken to ensure the independence of remuneration advice, the government also hopes to bring about a cultural change towards greater accountability around the use of remuneration consultants.

Prohibiting KMP from voting in remuneration matters

The bill also addresses conflicts of interest by prohibiting the company’s directors and key executives (or key management personnel) and their closely related parties from voting their shares in the non-binding vote on the remuneration report.

Currently, the Corporations Act does not prohibit key management personnel who hold shares in the company from participating in the non-binding shareholder vote on remuneration.

There is a real, as well as perceived, conflict of interest when key management personnel vote on their own remuneration packages.

As these directors and executives have an interest in approving their own remuneration arrangements, allowing them to participate in the non-binding vote may result in a higher approval rating on the remuneration report than might otherwise be achieved.

The bill prohibits key management personnel and their closely related parties that hold shares from participating in the non-binding vote on their own remuneration arrangements, as well as on the spill resolution.

Key management personnel and their closely related parties would also be prohibited from voting undirected proxies on the remuneration report and the spill resolution, except when they are the chair of the meeting and the shareholder has indicated their informed consent on their proxy voting form for the chair to exercise the proxy.

The bill also ensures that executive remuneration remains linked to performance by prohibiting key management personnel from hedging their incentive remuneration.

Incentive remuneration aligns the interests of management with the interests of shareholders. However, it is currently possible for directors and executives to hedge their exposure to incentive remuneration.

This is a practice that is inconsistent with a key principle underlying Australia’s remuneration framework—that remuneration should be linked to performance.

Under the new law, key management personnel and their closely related parties will be prohibited from hedging the key management personnel’s incentive remuneration.

No vacancy

The bill also contains a measure to prevent boards declaring ‘no vacancy’ without explicit shareholder consent.

The ‘no vacancy’ rule allows a board to declare that it has no vacant positions even though the maximum number of directors allowed by the constitution has not been reached.

The ‘no vacancy’ rule provides boards with considerable power over the composition of the board, making it difficult for non-board-endorsed candidates to be elected.

The bill enhances the accountability of boards by ensuring that companies will be required to obtain the approval of their members for a declaration that there are no vacant board positions. A board may choose to declare ‘no vacancy’ where: its constitution allows such a declaration; there are fewer directors than the maximum number; and where a non-board-endorsed candidate has nominated for a board position.

Cherry picking

This bill also introduces amendments which ensure the enfranchisement of each shareholder who chooses to exercise their vote at an annual general meeting or extraordinary general meeting.

Proxies are allocated to directors or the chair by shareholders that are not able to attend a company meeting but still wish to vote. Shareholders can vote directed proxies, which specify how they wish to vote on a resolution. However, under the current law all directors except the chair have the ability not to exercise proxy votes that do not accord with their own views on a resolution and to exercise only those proxy votes that do support their position. This is called cherry picking. Cherry picking disenfranchises shareholders who made specific declarations about their intentions to vote and can result in outcomes that do not clearly reflect shareholder views on a resolution.

This bill ensures that all proxies will be voted. Either the nominated proxy holder will vote as directed or, if a proxy holder does not register at the meeting or the proxies are not voted by the proxy holder, the proxies will default to the chair, who has a duty to vote them as directed. This bill ensures that the wishes of shareholders can no longer be ignored.

Range of individuals named in the remuneration report

The bill also contains a measure to limit the remuneration details required to be disclosed in the remuneration report to the key management personnel of the consolidated entity. This will simplify the disclosures in the remuneration report to enable shareholders to better understand the company’s remuneration arrangements. This will also reduce the regulatory burden on companies, while maintaining an appropriate level of accountability.

Conclusion

While Australia’s current remuneration framework is strong, it is important that we are not complacent.

The Productivity Commission, while noting that Australia’s remuneration framework is highly ranked internationally, has recommended that the framework be further strengthened.

This bill will give unprecedented power to shareholders, improve the accountability of company directors on remuneration issues, address conflicts of interest that exist in the remuneration setting process and promote a culture of responsible remuneration practices.

These are significant but responsible reforms that will maintain Australia’s international competitiveness, while ensuring that boards are accountable to shareholders and the processes for remunerating executives are transparent.

Finally, I can inform the chamber that the Ministerial Council for Corporations was consulted in relation to the amendments to the laws in the national corporate regulation scheme, and has approved them as required under the Corporations Agreement.

I therefore present the explanatory memorandum to the bill and commend the bill to the House.